Takeaways from Exencial’s ESG Study

August 21, 2020

We have seen an increase in client inquiries over the last few years surrounding environmental, social and governance (ESG) investing.1 This is being driven, at least in part, by an uptick in media coverage and research touting ESG investments.2

As more and more ESG-related investment products have debuted, we decided to conduct a brief internal study to see how many of these funds are available and how they’ve performed.
 

Considerations

Before we dive into the results of the study, here are a few key notes to consider:

1. There are no industry standards for defining and scoring ESG. While there are some better-known methodologies that investors and asset managers use as a benchmark (such as MSCI) there is not a clear industry standard for criteria and scoring. A primary concern to one ESG investor may not be important to another. This creates some challenges in identifying which funds to classify as ESG strategies, not to mention how the ESG strategies are executed.

2. There are relatively few ESG funds, fewer with a five-year history. While more ESG strategies have come to market recently, few have the kind of history that would allow for a meaningful study. Using the Morningstar database of ESG-related funds, we identified 120 U.S. large company ESG funds with at least a five-year record. 3 Other asset classes, such as small companies or international stocks, had far fewer strategy options. For this reason, we confined our study to the U.S. large cap space.
 

Results

There were two surprising results from this study. First, we initially hypothesized that ESG methodologies and scoring would favor technology firms and that ESG strategies would therefore be overweighted in technology sector holdings. Technology’s surge over the last few years4 would therefore explain why there have been so many recent articles about ESG investing.

What we found, however, was that ESG funds had no greater weight on average to technology names than their broad market peers – about 25% of the S&P 500 index is technology, for example.5 While some funds did have overweights, just as many had underweights.

Secondly, we could not see any distinct outperformance of ESG funds, to which many articles had alluded. On average, we saw that ESG strategies underperformed when compared against their broad market benchmarks, as seen in the chart below.

Essentially, strategies that overweighted tech tended to have better-than-average performance and those that underweighted tech tended to have lower-than-average performance. However, the funds on average underperformed broad market benchmarks.
 

Takeaways

Our study is not meant to dissuade investors from utilizing ESG strategies. We believe there are some ESG metrics that very well may lead to better outcomes for investors, such as favoring those companies with greater transparency in reporting (governance). We have recommended ESG funds and strategies (such as the Exencial SELECT stock strategy that incorporates several ESG metrics) that our clients can utilize.

We did not find a record of ESG fund outperformance within the Morningstar set we studied. However, the impact of ESG investing on markets and prices will almost certainly grow in coming years. We will continue to closely monitor developments in this space and determine how ESG metrics may affect our portfolios.

If you have any questions about investing in ESG, please contact your Exencial advisor.

Sources:
1. Investopedia (2/25/20) – Environmental, social, and governance (ESG) criteria
2. Morningstar (4/16/20) – U.S. ESG funds outperformed conventional funds in 2019
3. Exencial Wealth Advisors (8/20/2020) – Internal Study
4. Zacks Investment Research (5/19/20) – Tech sector outperforming this year: Best ETFs, stocks
5. The Balance (5/28/20) – What is the weighting of the S&P 500?

The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities. There is over USD 9.9 trillion indexed or benchmarked to the index, with indexed assets comprising approximately USD 3.4 trillion of this total. The index includes 500 leading companies and covers approximately 80% of available market capitalization.

The Russell 1000® Growth Index measures the performance of the large- cap growth segment of the U.S. equity universe. It includes those Russell 1000® companies with higher price-to-book ratios and higher forecasted growth values. The Russell 1000® Growth Index is constructed to provide a comprehensive and unbiased barometer for the large-cap growth segment. The index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect growth characteristics.

The Russell 1000® Value Index measures the performance of the large- cap value segment of the U.S. equity universe. It includes those Russell 1000® companies with lower price-to-book ratios and lower expected growth values. The Russell 1000® Value Index is constructed to provide a comprehensive and unbiased barometer for the large-cap value segment. The index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect value characteristics.

PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RETURNS. Information and opinions provided herein reflect the views of the author as of the publication date of this informational piece. Such views and opinions are subject to change at any point and without notice. Some of the information provided herein was obtained from third-party sources believed to be reliable but such information is not guaranteed to be accurate. In addition, the links provided within are for convenience only and the provision of the links does not imply any sponsorship, endorsement, or approval of any of the content. We do not guarantee the content or its accuracy and completeness. The content is being provided for informational purposes only, and nothing within is, or is intended to constitute, investment, tax, or legal advice or a recommendation to buy or sell any types of securities or investments. The author has not taken into account the investment objectives, financial situation, or particular needs of any individual investor. Any forward-looking statements or forecasts are based on assumptions only, and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. Any assumptions and projections displayed are estimates, hypothetical in nature, and meant to serve solely as a guideline. No investment decision should be made based solely on any information provided herein and the author is not responsible for the consequences of any decisions or actions taken as a result of information being provided herein. There is a risk of loss from an investment in securities, including the risk of total loss of principal, which an investor will need to be prepared to bear. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor’s financial situation or risk tolerance. Exencial Wealth Advisors, LLC (“EWA”) is an investment adviser registered with the Securities & Exchange Commission (SEC). However, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. EWA may only transact business in those states in which it is registered, notice filed, or qualifies for an exemption or exclusion from registration or notice filing requirements. Complete information about our services and fees is contained in our Form ADV Part 2A (Disclosure Brochure), a copy of which can be obtained at www.adviserinfo.sec.gov or by calling us at 888-478-1971.

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